Initial coin offerings ("ICOs") are facing increased regulatory scrutiny, and are likely to be seen as securities by agencies. We've written before about the securities exemptions ICOs may use to comply with the Securities and Exchange Commission (the "SEC"): Reg D, Reg CF and Reg A+.

Reg A+ (Tier 2, in particular) has started to get attention in the cryptocurrency world because it offers advantages over the others that make the most sense for digital assets.

The US House of Representatives has passed the "Regulation A+ Improvement Act" (the "Reg A+ Act") that increases the cap on investments under Reg A+.

Increased Reg A+ Caps

Reg A+ is divided into Tier 1 and Tier 2. If you issue an exempt security offering under Tier 1, you can raise up to $20m in a 12-month period. If you issue the offering under Tier 2, you can raise up to $50m in a 12-month period.

The new Reg A+ Act would increase the investment cap by 50% ($30m for Tier 1, $75m for Tier 2).

ICOs & Reg A+

Several ICOs have already used Reg A+: Gab, RideCoin and WeDemand. So Reg A+ has been shown to work in practice for crypto offerings. And with an increase in capital raising potential, it will likely increase.

Limits

There are still a few key limits on using Reg A+:

You can only use SEC-approved exchanges to sell the issued securities.

It requires anti-money laundering checks for all investors.

It requires "offering circulars" that are more extensive than white papers and, for example, require disclosure of risks.

The cryptocurrency market is a prime targets for broker-dealer regulation.

Brokers and dealers are people or businesses that are in the business of buying and selling securities. The formal definitions are below, but, in essence, a broker is an entity like E*Trade that acts as an intermediary between buyers and sellers. You want to buy, say, Tesla stock, so you go on E*Trade, place an order, and E*Trade finds someone selling it. This is the most traditional instance of a broker-dealer.

The "less" traditional type of broker-dealer happens when a company is selling its own securities. If it's not an IPO, the company will want to promote the fact it's selling it's securities. It could hire a third party marketing agency that would go out and promote . . . but that would make the marketing agency "in the business" of buying/selling securities, even if it's not doing any buying or selling. It's still making those transactions happens, so the marketing agency would be a broker-dealer. So anyone a company has promote its securities would count as a broker-dealer.

Broker-Dealer Requirements

As a general rule, brokers and dealers are required to register with the SEC and joint a self-regulatory organization (“SRO”). The main US SRO is the Financial Industry Regulatory Authority (“FINRA”). There may also be state registration requirements, depending on your state.

If you act as a broker-dealer without properly registering, the SEC or state securities regulators can seek significant monetary penalties and/or criminal sanctions. Also, they may require rescission (basically, an undoing of the investment).

Why Broker-Dealer Laws Matter for Crypto

Given Chairman Jay Clayton of the Securities & Exchange Commission’s (“SEC”) recent aggressive view that “every ICO I’ve seen is a security,” these broker-dealer laws (“B-D laws”) will apply to most cryptocurrencies, whether utility or not.

Remember how a marketing agency that promotes a securities issuing would be a broker-dealer?

Replace "securities issuing" with ICO.

Now think of all the ads, tweets, emails, shills, etc. you have received and seen promoting ICOs.

*cough* John McAfee *cough*

Yeah . . . kind of a potentially big problem for crypto.

Don't worry, McAfee's days are probably numbered.

Broker-Dealers, Defined​First off, remember that the SEC is viewing most crypto as securities. So when you see the word “security,” it would apply to a crypto or ICO that's being shilled.The Securities Exchange Act defines “broker” as any person:

Engaged in the business of effecting transactions in securities

For the account of others.

Dealer is defined as any person:

Engaged in the business of buying and selling securities

For his or her own account

Through a broker or otherwise.

The key difference is that brokers buy and sell securities for others, while dealers do so for themselves.Note that these definitions are really broad. You don’t have to be involved in the actual purchase or sale of a security, you just have be involved somehow. This can mean you promoted the security (read: ICO) or introduced the issuer to an investor.The “Finder” ExceptionThe most cited exception to B-D registration is for a "finder," which is someone that finds investors or makes referrals. However, this is a very narrow exception. If a person has helped effect any securities (again, read: ICO) transaction more than once, this exception probably won't apply.

The main factors in determining if someone is a “finder” or “broker-dealer” are:

Regularity - Do they regularly participate in effecting securities transactions (broker)? Or was it a once-off, isolated event (finder)?

Participation - Do they participate in any solicitation, negotiation, and/or execution of the securities transactions (broker)? Or are they absent from the “substance” of the deal (finder)?

Compensation - Is compensation related to the outcome or size of the transaction/deal (broker)? Or was it a one-time flat fee (finder)?

Handling Securities - Do they handle securities (ICOs) or funds of those involved in the transaction (broker)? Or do they have no control and interaction with the assets/funds (finder)?

The determination is made on a case-by-case basis, and if any of the factors weigh in favor of being a broker . . . you’re probably a broker. Again, circumventing B-D laws is not easy; these laws are meant to apply to a lot of situations.Other ExclusionsThere are a few other exclusions from this requirement to register. The most relevant for crypto are:

Associated Persons – This is for employees, independent contractors, and the like that are working for a registered-broker, if they are properly supervised. They may have to register with an SRO, though, and this exemption only covers the person's activities in their capacity as an agent for the registered broker-dealer.

Issuer Exemption – Issuers that only buy/sell their own securities are not broker-dealers and do not need to register.

Associates Persons of the Issuer – Associated Persons of an issuer (employee, contractors, agents, etc.) don’t have to register if they: (1) aren’t statutorily disqualified (e.g., violated securities laws in the past in a way that they are now barred from broker-dealer activities); (2) aren’t paid on commission or similar transaction basis; (3) are not an associated person of a broker or dealer; and (4) limit their sales to certain, specified activities (e.g., only sell to registered broker-dealers, insurance companies, and certain other buyers).

Foreign Broker-Dealer Exemption – Broker-dealers that are not physically located in the US, and do not try to induce any securities transactions in the US are exempt.

Best OptionsThe most common way to be compliant with B-D laws is to hire someone as an employee, and pay them on a fixed, regular basis. That way they'll fit in the "associated persons of the issuer" exemption from registration.

Often, these employment arrangements include bonuses. Whether this is transaction-based compensation that would trigger B-D registration depends on the circumstances, but it generally should not be tied to how much “business” an ICO promoter brings in. Key features include:

When it’s paid (e.g., regularly vs. only after an investor is brought in);

When it’s determined it’s paid (e.g., at quarterly meetings vs. only after an investor is brought in),

When the person is informed of the bonus (e.g., at the end of a quarter vs. right after an investor is brought in), and

Whether the bonus varies and correlates with the person’s success in bringing in investors.

But Seriously, Consult Legal CounselB-D activities have serious repercussions if handled incorrectly, and the exceptions are narrow. This is an area of law where anyone that does any investing-related activities should talk to a lawyer.

​If a cryptocurrency or altcoin is a security, it must be offered to US investors in an offering registered with the Securities and Exchange Commission ("SEC") or fit into an exemption.

Registration can cost anywhere from hundreds of thousands of dollars to well over a million, and requires that you disclose a lot of information you may not want public. So finding an exemption is usually the preferred route.

Right now, the main exemptions for securities offered in the US are: Reg D, Reg A+ and Reg CF. There is also Reg S for foreign securities offerings, and you’ll read about that in a separate post.

Preemption & Disclosure

Two quick notes before you learn about the exemptions:

State Preemption - Some SEC exemptions “preempt” state securities laws. This means that if your cryptoasset offering is exempt under federal SEC regulations, that exemption “preempts” any state regulation, and you don’t need to consider state security laws.

Preemption is important because, for example, if you have investors in several states, and you use an exemption that does not preempt state law, you will have to separately comply with the securities laws of every state in which an investor lives, and possibly with every state in which a potential investor lives.

Disclosure – Required disclosures are generally not a good thing for an issuer because: (i) they open your kimono to the SEC and/or public, (ii) they create additional opportunities for SEC action (for example, the SEC can take action against an issuer if anything in a disclosure is perceived as misleading), and (iii) they can add significant fees to the cost of the exemption.

Private Offerings

Private offerings are the most common security exemption. The key feature that makes private offerings “private” is that you can’t “generally solicit” your offering, meaning you can’t publicly market it.

There is a broad “private offering” exemption via Section 4(a)(2) of the Securities Act of 1933. But Section 4(a)(2) is open-ended and determined on a case-by-case basis, so most private offerings are done through Regulation D ("Reg D").

The upside of this attention is that you should want the Bitconnects of the world gutted by regulators.

The downside is blockchain-based businesses need to start treating their native cryptoassets as securities. Even tokens created pursuant to a SAFT aren’t likely safe based on recent SEC stances and statements.

As a result, you will likely see digital asset issuers increasingly relying on securities law exemptions.

One option is for ICOs that wish to be compliant is to qualify as an exempt securities offering under Regulation Crowdfunding (“Reg CF”). Indeed, some ICOs, like Indeco, have already used this option since late 2017.

Reg AT is aimed at reducing market disruptions from automated trading. The best example is probably the May 6, 2010 “Flash Crash” when automated trading caused the S&P 500, Dow Jones and Nasdaq to crash and rebound almost 10% in 36 minutes (...tame compared to crypto, I know).

If implemented, Reg AT could require pre-trad risk controls by:

Anyone trading with AT systems;

Certain futures commission merchants (aka, a futures broker); and

“Designated contract markets” (“DCMs”) that execute the orders of anyone trading with AT systems.

The rule would also impose registration requirements on traders that electronically submit orders directly to a DCM, without routing them through a member of a derivatives (aka, futures) clearing organization.

In legal context, "chilling" refers to the fact that too much regulation may slow or kill the development of innovation. E.g., regulation of crowdfunding is considered to have been implemented too quickly, stagnating the development of crowdfunding.

Given Chairman Giancarlo’s favorable treatment of crypto, it’s not surprising he’s hesitant to clamp down before the CFTC has more time to watch the development of relatively new technology develop.

Automated trading is valuable in and of itself, but all the algorithms, code and lessons learned in its development could transfer to other fields. It’s possible that a trading algorithm can pick up certain patterns that may surface in diseases, for example.

Going Forward

In early 2017, the CFTC extended the time period in which it was accepting comments on the proposed Reg AT to May 1, 2017. That day has come to pass, and no public developments have happened with Reg AT.

Given that the Trump administration is keen on less regulation, and Chairman Giancarlo’s is hesitant to regulate new tech too quickly, we may not see any form of the proposed Reg AT implemented at all.

It’s safe to say automated trading isn’t going anywhere. Eventually, regulations will need to be imposed to protect against flash crashes and fraud. But it doesn’t look like that will be happening any time soon.

In everyday terms, commodities are raw materials or products. They are goods that are typically transformed into more consumable products or uses. Common examples are steel, coffee beans or pork bellies.

In the pork bellies context, Eddie Murphy gives some deep insight in Trading Places on how commodities investing works.

The Arizona Senate has passed a bill that would allow state residents to pay their taxes in cryptocurrency

Senate Bill 1091 still needs to pass in Arizona’s House of Representatives, but the fact a bill like this has passed in the Senate is unprecedented in the US. Under the bill, the Arizona Department of Revenue would convert the crypto tax payments into US dollars within 24 hours.

Fiat & Taxes

Ok, great, so Arizona is open to experimenting with crypto. So what? Why does it matter, especially if Arizona would just immediately convert the crypto to dollars?

Because there are convincing arguments that what makes fiat money valuable as “fiat” is the fact it’s the only currency the government you live under will accept for tax payments.

Right now most ICOs are for currencies or utility tokens. But there’s a third category that many believe will be more widespread and useful: security tokens.

What Is A Security Token?

A "security token" is a blockchain-based asset that functions like a traditional security. Instead of owning stock in a company, you would own a security token. That token would come with voting rights, distribution rights, and/or liquidation rights.

Security tokens are a way to bring blockchain efficiencies to traditional equity. Companies can issue tokens instead of stock, and have an up-to-date blockchain ledger of its shareholders at all times.

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